Computing the Price-Earnings Ratio The income statement, statement of retained e

Question

Computing the Price-Earnings Ratio The income statement, statement of retained earnings, and balance sheet for Somerville Company are as follows: Somerville Company Income Statement For the Year Ended December 31, 2016 Amount Percent Net sales $8,281,989 100.0% Less: Cost of goods sold (5,383,293) 65.0 Gross margin $2,898,696 35.0 Less: Operating expenses (1,323,368) 16.0 Operating income $1,575,328 19.0 Less: Interest expense (50,000) 0.6 Income before taxes $1,525,328 18.4 Less: Income taxes (40%)* (610,131) 7.4 Net income $ 915,197 11.0 * Includes both state and federal taxes. Somerville Company Statement of Retained Earnings For the Year Ended December 31, 2016 Balance, beginning of period $1,979,155 Net income 915,197 Total $2,894,352 Less: Preferred dividends (80,000) Dividends to common stockholders (201,887) Balance, end of period $2,612,465 Somerville Company Comparative Balance Sheets At December 31, 2015 and 2016 2015 2016 Assets Current assets: Cash $2,875,000 $2,580,000 Marketable securities 800,000 700,000 Accounts receivable (net) 939,776 690,000 Inventories 490,000 260,000 Other 93,000 74,261 Total current assets $5,197,776 $4,304,261 Property and equipment: Land $1,575,000 $1,067,315 Building and equipment (net) 1,348,800 1,150,000 Total long-term assets $2,923,800 $2,217,315 Total assets $8,121,576 $6,521,576 Liabilities and Stockholders' Equity Current liabilities: Notes payable, short term $1,170,127 $ 543,641 Accounts payable 298,484 101,500 Current maturity of long-term debt 3,000 2,000 Accrued payables 200,000 57,780 Total current liabilities $1,671,611 $ 704,921 Long-term liabilities: Bonds payable, 10% 500,000 500,000 Total liabilities $2,171,611 $1,204,921 Stockholders' equity: Preferred stock, $25 par, 8% $1,000,000 $1,000,000 Common stock, $1.50 par 337,500 337,500 Additional paid-in capital* 2,000,000 2,000,000 Retained earnings 2,612,465 1,979,155 Total stockholders' equity $5,949,965 $5,316,655 Total liabilities and stockholders' equity $8,121,576 $6,521,576 * For common stock only. Also, assume that the price per common share for Somerville is $8.10. Required: Compute the price-earnings ratio. Round your answer and intermediate calculations to two decimal places.

Explanation / Answer

Earning per share = (915197-80000)/337500 = 2.47 per share

Price earning ratio = MPS/EPS

= 8.10/2.47

Price earning ratio = 3.28

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